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Global Crisis Blog

Martin Wolf Lifts the Fog:    What in the World is Going On in Europe


Martin Wolf

By Shlomo Maital

    Among the columnists I follow closely is FT columnist Martin Wolf.  Born in 1946, Wolf had a career with the World Bank before joining a research institute, then the Financial Times. He is regarded as a leading business columnist, whose analysis is as deep as it is clear. On Nov. 30, his article “Why the Irish crisis is such a huge test for the Eurozone” is worth careful reading.  Let’s go through it step by step together.

1. “A currency union (i.e. the euro) causes crises”.  Some countries (Germany) in the union control wages, others (Portugal, Ireland, Spain) do not.  So they become less competitive, and their economies weaken.  Governments then engage in deficit spending to sustain employment, when other countries use exports.  This creates confidence crises in their bonds, a la Greece.

2.  “A currency union has a common interest rate”.  Interest rates are everywhere the same. But different countries have different risks.  So in some countries, the common interest rate will seem excessively low, leading to credit booms and asset bubbles.  The result is a huge credit crisis.  If exchange rates could change,  the Irish punt and the Greek drachma could fall, stimulating exports. But they no longer exist. So a currency crisis becomes, instead, a credit crisis, as lenders stop buying sovereign bonds.  If Ireland, for instance, still had its pound linked to the British pound, it would have fallen, helping Ireland’s economy.  That is no longer the case.

3.  Facing the crisis, governments offer such high interest rates on their bonds (they have to, all governments need to roll over their debt), that they destroy their credibility, rather than strengthen it. (A high and rising risk premium on Irish bonds drives investors away).   Ireland erred. Instead of letting Allied Irish Bank creditors take a ‘hit’, wiping out part of the debt, the Irish government assumed that debt, saddling Irish people with billions of euros in debt for a whole future generation. 

4.  Will the euro zone survive?  Possibly not.  German reluctance to continue to bail out irresponsible deadbeat countries may force peripheral weak countries to return to their own currencies. This too is not viable. When Ireland re-adopts its punt, money will flee and Irish government debts will soar disastrously.  The key issue is Spain. Spain has to roll over some 250 billion euros in debt alone this year, and its PM Zapatero, a Socialist, blames everyone but his own government’s mismanagement. 

5.  Survival of the euro zone is a political, not economic, issue.  Countries in Europe, including Italy, used to have currency crises.  Today, in the euro, they have credit crises.  These crises have forced them to swallow enormous debts created by private-sector banks and impose austerity that increases unemployment and reduces welfare spending.  Countries will make the following calculation:  which is worse, a currency crisis or a credit crisis, in which the EU itself does not come to their aid?  If the answer is ‘currency crisis’ – bye bye Euro.    


Global Crisis/Innovation Blog

Blame the Fed – Again!




Frank Partnoy

Blame the Fed for irresponsibly slashing interest rates during 2001-4,  causing the worst part of the U.S. housing bubble. [See my editorial in Barrons, Dec. 15, “Blame the Fed”, refuting Allan Greenspan’s self-serving and misleading article*].   

   Blame the fed, again,  for irresponsibly bailing out foreign banks in 2007, then choosing NOT to bail out Lehman Brothers, a disastrous error,  then claiming (Bernanke) it didn’t rescue Lehman brothers because to do so would have broken the law.  False. 

   Now we know the truth.  A law suit brought by Bloomberg, under Freedom of Information, demanding that the Fed open its books and reveal what it did, to whom it loaned and how much, and against which collateral,  together with the Dodd-Frank Act, in which a tiny clause required the Fed to come clean, has now brought revealing documents from the Fed. 

    Why did it take a law suit?  Why did the Fed, the ultimate regulator, the body that demands transparency from the banks it regulates, not come clean itself?  Why did it hide the truth? 

    And the truth is this, according to Frank Partnoy, professor at U. of San Diego and author of Infectious Greed: How Deceit and Risk Corrupted the Financial Markets, a remarkable indictment of Wall Street skullduggery.  (See the Financial Times, Dec. 3, 2010 **).   The American Fed was lending prolifically, in 2007, to the tune of a staggering $3.3 trillion (more than 20 % of US annual GDP).  Much of this lending went to foreign banks!  Says Partnoy, based on his analysis of the newly-released Fed data:  “the Fed’s new data show it was well aware of the crisis [in 2007] and had the ability to lend tens of billions of dollars, but it opted to lend primarily to non-US banks.  Those non-US banks, incidentally, lent some of the money back to troubled US banks. 

    Writing in the same remarkable issue of FT, Gillian Tett notes that the Fed, with its staggering $3.3 trillion in new lending, was replacing the collapsed securitization market, supplying liquidity where none was available, not only in the US but also in Europe.  This raises the question, for ECB head Jean Trichet, and for the EU in general:  Where were you? What were you thinking? Why were you asleep? 

     Scholars will doubtless research 2007-9 intensively.  As more and more data appear, we see a mixed picture of aggressive Fed action mixed with inexplicable and disastrous decisions.  We can, indeed, as a result, blame the Fed.  


* Alan Greenspan.  The Crisis.  Brookings Papers on Economic Activity:  Spring 2010, pp. 201-246.

** Frank Partnoy.  “Sunlight shows cracks in crisis rescue story”.  FT, Comment.

Blog entries written by Prof. Shlomo Maital

Shlomo Maital
December 2010
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